O’Shaughnessy on active management

Recently, Jim O’Shaughnessy, the author of What Works On Wall Street, took to Twitter with his first tweet storm (basically a short post in a series of tweets). In it he spoke about his thoughts on active management. I thought I should capture it for future reference. I’ll add comments and links throughout.

What Works On Wall Street (4th edition) is basically 681 pages on a handful of factors; mainly value and momentum, with minor roles played by small-cap, equal-weighting, and quality.

The lack of ability to focus on the long term is the number one behavioral issue that prevents investors from being able to execute the strategies outlined in the book. It is also the biggest issue in preventing investors from even achieving the posted returns for index funds (see total returns vs investor returns in Morningstar for example).

Here is the link to his base rate post. Base rates are one of the most important and overlooked aspects of choosing a strategy. Strategies with higher base rates will be easier to stick to in the long run. Choosing strategies with high base rates increases your chances of success. Here is a post I did on base rates.

Another really hard thing for investors to focus on – process. Especially in today’s financial news, social media world. You need an investing process that actively tunes out noise. For me, one of the most valuable parts of What Works On Wall Street is his discussion of process.

Composite factors vs a single factor is key. Companies are capitalized in different ways, are in vastly different businesses. Just because they are cheap on one factor doesn’t mean they’re truly a value. Also, true in reverse. Now for some nitty gritty details.

The VC2 (Value Composite 2) ranking used in the quant strategies here is an equal weighted composite of these plus P/B. O’Shaughnessy used P/B in the latest edition of the book but since seems to have dropped it. See this post. P/B works but has long periods of underperformance. I still use it in my VC2. During my backtest period, back to 1999, the VC2 with P/B, outperforms.

Related to #4. What you don’t own matters a lot.

Back to a higher level focus now…

See here on 3 yr track records. Long term proven strategies are the way to go.

Here is the link in this tweet. Re-balancing helps take some of the sting out of underperformance.

This is so important. Your worst enemy as an investor is staring at you in the mirror.

Don’t ask yourself this after a good year. For example, right now quant investing looks fantastic after a stellar 2016. It didn’t look so great at the end of 2015 though.

Agree 100%. I even believe that are some investors whose only real option is to be in cash or the shortest term of safe investments. They can’t even take the volatility of 10yr gov’t bonds. But the best approach would be to just hire Vanguard for 0.3% per year.

A good advisor can really help. But only if you understand their process so you don’t fire them after a few years of underperformance.

There you go. Lots of gems in here to remember for the long term. If you’re interested in quant investing you need to go read the book.

 

Full Disclaimer - Nothing on this site should ever be considered advice, research or the invitation to buy or sell securities. These are my personal opinions only.

3 thoughts on “O’Shaughnessy on active management

  1. Great info from OShaughnessy. And, I liked your added commentary. Like you stated, quant sounded great in 2016 but not as great in 2015. It’s good you documented this info for the future. PS – I like the additional info you put on your Portfolios page – helps when trying to review. Thanks for the info.

  2. Paul, thanks for continuing to give us interesting things to digest. You mentioned you will be focusing on economics in future blog reports. After decades of falling interest rates, and 8 years of ZIRP, we now see rates start to rise. Rising rates are often considered to be bad for bonds and bad for stocks. Have you done any studies of quants that do best in times of rising interest rates?

    Secondly, changing to a republican US government should be good for banks, and possibly energy. However, WWOWS shows max drawdowns of around 61% for both. Have you looked at applying SMA and UI to these quants to reduce risk?

    Thanks for all you do for us.

    1. All of the TAA and/or quant portfolios have been through all kinds of environments. So, yes, they have been tested
      in times of rising rates.

      SMAs don’t work in quant portfolios. SPY-UI does.

      Paul

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